Brambles bound to give Recall the push

Brambles has had its fingers in many pies since English immigrant Walter Bramble started transporting meat and produce between Sydney and Newcastle just over 120 years ago. Steel, waste-disposal services, mining services, and crane rental operations have all featured in its chequered history.

But as conglomerates have gone out of fashion, the group is now considering returning to its roots as a logistics company and focusing on the CHEP pallet-pooling business it has owned since the 1950s.

The immediate question is whether management at Brambles will put up for sale the document-storage business, Recall, that it got into in the early 1990s. A sale is probably not imminent; the company is expected to try to improve profit margins, which are running at about 15 per cent, before getting rid of it. But with Brambles having no obvious reason to keep Recall, which generates lower profit margins than CHEP (and operates in a more competitive market) most expect it will be put on the block sooner or later, leaving Brambles free to expand CHEP into emerging markets.

As growth in the mature markets of the US and Europe slows, Brambles is focusing on the faster-growing emerging markets. It initially moved into Latin America in the early 1990s and Asia later in the decade.

Brambles is not a forced seller of Recall, which some analysts estimate is worth as much as $US1.7 billion to $US1.8 billion ($1.5 billion to $1.6 billion). Others are more conservative, valuing it at $US1.3 billion to $US1.4 billion.

But what can Recall contribute to Brambles in the future? And does the group have the resources to run two very different businesses effectively?

The document services business faces some tough strategic challenges. The market leader, US group Iron Mountain, is considering whether to sell some of its digital businesses due to the difficulty of keeping up with rapid changes in technology as it introduces a strategic review under pressure from one of its largest shareholders, hedge fund Elliott Management Corporation.

If Brambles keeps Recall, which makes most of its money by storing documents in warehouses, it could still follow the lead of Iron Mountain and get rid of its digital operations – which account for just 3 per cent of its $US4.1 billion in group revenues – making some $US60 million to $70 million in the process, according to Macquarie Equities analysts.

They argue Brambles is likely to sell all of Recall only if at least half the proceeds can be invested in CHEP and its expanding reusable plastic crates operations, giving it the potential to earn higher returns on invested capital of about 20 to 25 per cent.

Recall’s return on capital invested in the first half of fiscal 2011 was 12 per cent. If Brambles were to sell Recall, it would also have additional cash to follow its consumer goods customers into rapidly growing markets such as China, India and Brazil.

The company has a comfortable balance sheet. It has “headroom”( the combination of its undrawn debt capacity and available cash) of some $US1 billion after its $US1.3 billion purchase last year of IFCO, the Amsterdam-based supplier of reusable plastic crates. IFCO’s focus on pallet pooling may encourage Brambles to push its pallets businesses in emerging markets harder.

It will also help diversify its earnings away from the US. Brambles derives some 90 per cent of its group revenue from mature Western markets, and generates most of its sales in Western currencies such as the US dollar, pound sterling and the euro.

The weakness in the US dollar against the Australian dollar is worrying some investors, with revenue generated in US dollars accounting for about one-third of the group’s total sales. Although Brambles reports earnings in US dollars, its shares trade on the Australian Securities Exchange and it pays dividends in Australian dollars. So while weakness in the US dollar relative to the Australian dollar can lift the group’s reported earnings, it can also be felt in Brambles’s share price valuation in Australia.

Some analysts argue that continued strength in the Australian dollar may put a ceiling on Brambles’s share price, because it devalues the group’s overseas earnings.

But analysts at the Commonwealth Bank argue that in the short term, Brambles’s share price will correlate with a rising Australian dollar, because it will benefit from the economic growth signalled by the dollar’s strength in parts of the world.

Still, Brambles is keen to diversify away from the US. One of IFCO’s attractions was its strong footprint in Latin America, where it has operations in Brazil, Argentina and Uruguay. Brambles entered Latin America in 1995 when it launched its CHEP business in Mexico and Chile, followed a few years later by Brazil and Argentina, then Guatemala in 2010.

The region is now Brambles’s biggest revenue generator in emerging markets, contributing some $US100 million in the first half of 2011 and, along with eastern Europe, is a key near-term contributor to growth.

But it is China, which contributed revenue of just $US10 million to Brambles in the first half, that is forecast to provide great growth opportunities due to the rise of “hypermarkets” (combinations of supermarkets and department stores). These have modern distribution systems, using pallets to transport goods to and from warehouses.

China’s hypermarkets and consumer goods groups use disposable pallets or rent pallets on “static hire” terms; this means they rent a specific number of pallets for their own use rather than being part of a broader pooling system in which pallets are transferred through the supply chain from factories to retail stores.

But Brambles expects China’s retailers and consumer goods companies to move to the pooling system as the retail sector develops. CBA forecasts CHEP China can increase its revenue by about 22 per cent a year over the next eight years, producing sales of about $100 million by 2019.